Price discrimination or price differentiation exists when sales of identical goods or services are transacted at different prices from the same provider. In a theoretical market with perfect information, perfect substitutes, and no transaction costs or prohibition on secondary exchange (or re-selling) to prevent arbitrage, price discrimination can only be a feature of monopolistic and oligopolistic markets, where market power can be exercised.
The effects of price discrimination on social efficiency are unclear; typically such behavior leads to lower prices for some consumers and higher prices for others. Output can be expanded when price discrimination is very efficient, but output can also decline when discrimination is more effective at extracting surplus from high-valued users than expanding sales to low valued users. Even if output remains constant, price discrimination can reduce efficiency by misallocating output among consumers.
Two necessary conditions for price discrimination are to be met if a price discrimination scheme is to work:
1. The firm must be able to identify market segments by their price elasticity of demand and
2. The firms must be able to enforce the scheme.
Source: http://en.wikipedia.org/wiki/Price_discrimination (as viewed on 22/02/2011)
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